Building a Hedge Fund in Australia with Exposure to the Chinese Economy

In 2010, China was Australia’s main trading partner for goods and services accounting for 19.1% of total trades . This Sinodependance enables on average an Australian balanced superfund to have an exposure of 11% of its net assets to the Chinese economy mostly due to the impact of mining giants such as BHP and Rio Tinto (more than 10% of the All Ordinaries Index). The first part of this assignment tries to identify companies and selection rules in order to set up a fund (named Super China Exposure) that invests in Australian listed companies with exposure to the Chinese economy. The second part gives details about weights of selected companies, then a pure-play strategy is established and finally the performance of this fund is discussed.

portfolio selection

Investment objective
Exposure to the Chinese economySuper China Exposure is designed to invest in companies that have an exposure to the Chinese economy with an active management strategy. The Fund is limited to Australian companies which reduces two major risks: political and exchange risks (Super China Exposure currency is AUD since it is designed for the Australian market). In order to minimise political risk and attract concerned investors about China’s political situation Super China Exposure invests in companies that do not have strategic subsidiaries in China (eg: BHP Billiton business in China is reduced to marketing and Mineral exploration ). According to this constraint, the fund aims at:

minimizing the risk/return ratio of stocks with positive alphas beat its benchmark (ASX small cap- refer to Portfolio evaluation section)

Security number and asset mixIn order to limit transaction costs and based on Meir Statman’s research, Super China Exposure fund invests in a moderate number of securities with exposure to the Chinese economy so that the risk/return ratio is minimized. This number is set at 15. Based on China’s 12th five-year plan release in March 2011 and analyst’s growth expectations Super China Exposure fund investment manager believes that Chinese growth will remain strong over the next years and share prices of Australian companies with exposure to the Chinese economy will continue to expand. To benefit from this expansion Super China Exposure fund invests 100% of its assets in equity securities.

Sector selectionA pure-play strategy (discussed in part 3) allows hedging against markets movements so diversification does not play a significant role in Super China Exposure strategy. Table 1 (please refer to appendix) summarises Australia’s exports per sector in 2010. Goods represent around 90.75% (AUD 58,402 million) of Australia’s total exports to China (AUD 64,356 million). In 2010, more than half of Australian exports to China are composed of Iron, ores and concentrate (AUD 34,681 millions). Companies within this industry will definitely belong to Super China Exposure fund but the fund manager also takes into account other sectors relying on the Chinese economy that would allow some diversification. China might continue to experience a high growth over the next years, all companies within sectors in Table 3 (please refer to appendix) are considered such as other crude material mining companies (ie copper) or mineral and fuel companies (ie crude petroleum). Table 2 shows the importance of education-related sector to China being the third biggest sector. For the time horizon 2011-2015, priority is though given to companies in table 3 (primary and manufactured product companies). The release of China’s 12th 5-year plan in March 2011 estimates a 7% GDP growth that might largely involve Australian companies in the development of transportations, urbanization or construction and renovation of 36 million apartments for low-income families. Service companies might be included in the future as their proportion of exports to China increases.

Security selection
As at 14 July 2011, 2321 companies were listed on the ASX and 994...

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HedgeFund Education Series
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